Germany: German anti-treaty shopping rules under scrutiny

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Alexander Linn

The Tax Court of Cologne has referred three separate cases
regarding the application of Germany's anti-treaty shopping
rules to the Court of Justice of the European Union (CJEU). The
court questions whether the rules are compatible with the
freedom of establishment principle in the Treaty on the
Functioning of the European Union (TFEU) and/or the EU
Parent-Subsidiary Directive.

Two of the cases involve the anti-treaty shopping rules that
applied during the period 2007-11, and were referred to the
CJEU in 2016 (pending as C-504/16, Deister Holding)
and August 31 2016 (pending as C-613/16, Juhler
Holding). These rules were amended from 2012 in response
to an infringement proceeding initiated by the European
Commission. In a decision dated May 17 2017, the Tax Court of
Cologne referred the current version of the anti-treaty
shopping rules (section 50d (3) EStG) to the CJEU.

In all three cases, a foreign entity had requested a refund
of German withholding tax on dividends, which was denied based
on the anti-treaty shopping rules. Under these rules, foreign
entities receiving payments subject to German withholding tax
will be entitled to a reduction of withholding tax only to the
extent they meet either a shareholder test (similar to a
derivative benefits test) or business income test (i.e. earn
income from active trading activities), unless the entity meets
both a business purpose and a substance test.

While the reason for the denial of benefits was slightly
different in each case, the main elements of the cases and the
EU law aspects are similar: a German entity in a similar
situation would benefit from a tax exemption without having to
meet any further requirements, but a non-resident entity
seeking relief from German withholding tax must meet very
strict substance and/or business purpose requirements. The Tax
Court of Cologne considers this disparity in treatment to be a
restriction of the freedom of establishment. Because the rules
are so stringent, the court also stated that the restriction
cannot be justified by the need to prevent tax avoidance since
it goes beyond what is necessary to achieve that objective
(proportionality principle). The court also stated that even
the revised rules violate the proportionality principle and
cannot be justified.

Since the German anti-treaty shopping rules are so strict
and often apply in situations that are not driven by a tax
avoidance motive, the outcome of the cases will be important
for German inbound investors. Foreign taxpayers that suffered
withholding tax on German dividends due to the application of
the anti-treaty shopping provisions should monitor developments
and keep relevant assessments open.